Editor's Choice: ‘Known unknowns’ cast shadow over Europe

Switzerland’s surprise move on Thursday to abandon a ceiling for its currency against the euro has sent shock waves throughout global capital markets.

The move sparked a massive rally in the Swiss franc which soared as much as 39% before easing to around SwFr 1.06 against the euro at the end of the day, an increase of around 30%.

Switzerland may have a special status as a safe haven for foreign capital in Europe, but the currency intervention by the Swiss central bank raises the question of how other smaller economies outside the eurozone will react to the widely expected loosening of monetary policy by the European Central Bank.

The ECB is expected to embark on a new sovereign bond buying programme next week aimed at boosting economic growth and pulling the eurozone away from the brink of deflation. Investment bank Barclays expects this will trigger other smaller European economies, especially in Scandinavia, to take measures to brake inflows of foreign capital in their own country. The UK central bank is in the same boat.

The Swiss currency intervention puts into sharp relief the ‘known unknowns’ facing Europe’s real estate industry. To quote the Emerging Trends in Real Estate Europe 2015, a report published jointly by the Urban Land Institute (ULI) and PwC which was issued this week, they are not ‘event risks’ in the strict business sense. These events are ones already taking place, fixed in the calendar or very much foreseeable. What is unknown, however, is quite how they will unfold during 2015 and how markets will react.

WALL OF CAPITAL OVERRIDES CONCERNS ABOUT OVERPRICED ASSETS
Having said that, most of those canvassed by Emerging Trends Europe believe the outlook is bright for their business in 2015. Indeed, Europe is awash with capital, fuelling optimism that 2015 will be another good year and overriding concerns about overpriced assets. Equity-rich sovereign wealth funds (SWF) and pension funds from Asia and North America continue to target European real estate markets and will play an even bigger role in 2015, according to the report. Moreover, global capital is here to stay: Asian investors will enter the EU market permanently within two to three years, the report predicted.

But there are some lengthening shadows: worsening economic conditions in much of continental Europe and talk of possible deflation; uncertainty created by the UK’s forthcoming general election; geopolitical events that threaten the region, including Russia’s conflict with Ukraine and those in the Middle East; and, from left field, the emergence of the Ebola virus in Africa.

It would be going too far to say that Europe has declared war on Islamic terrorists following the execution in Paris last week of the 10 Charlie Hebdo staff and two French police agents. But the deployment of troops to protect ‘sensitive sites’ in Paris certainly evokes memories of military operations. And France is by no means an isolated case. The whole of Europe is on edge after Belgian authorities succeeded in pre-empting what they called a major terrorist attack on Thursday, killing two suspects in a firefight and arresting a third in a vast anti-terrorism operation.

INVESTORS GRAVITATE TOWARDS SAFE BETS
It is still early days to make any predictions on how Europe’s war on terrorism will unfold and affect investment sentiment. But it is safe to assume that most real estate investors will continue to gravitate towards the safe bets in Europe in terms of cities and sectors. In that sense there are few surprises in the Emerging Trends rankings. Berlin has ousted Munich from the top spot for investment prospects in Europe this year while Dublin ranks again in second place.

Madrid has shot up the rankings for investment prospects this year and now sits in third place due to growing interest from international investors. Hamburg has slipped by one place this year, but this is mainly due to investors looking to smaller, less established markets rather than any real decline in the city’s fundamentals. Athens is the biggest – and possibly most surprising - mover on the list, climbing 23 places to number 5.

The five leading cities are a mix of German stalwarts and recovery plays. Competition for prime assets in Europe’s major real estate markets is leading property investors to continue their move into secondary assets and recovering markets, the report concluded. Fully two-thirds of those canvassed by Emerging Trends Europe say there’s a need to consider secondary markets or assets. Their willingness to take on more risk is reflected in this year’s ranking of city investment prospects. The secondary cities that have seen a surge in popularity for real estate investment opportunities were all hit particularly hard during the last market downturn. Other cities that have shot up the rankings aside from Madrid and Athens include Birmingham (up 14 positions), Amsterdam (up 17 positions) and Lisbon (up 17 positions).

MOOD HAS DARKENED IN FRANCE AND RUSSIA
While prospects have improved in most countries and cities in Europe, a big switch in sentiment has occurred in France, where only 40% of respondents now think they will be growing their profits in 2015, whereas last year, half had been expecting an improving trend. Though Paris remains a go-to destination for many investors, France’s stuttering economy and government have clearly darkened the mood. But the darkest mood is in Russia, where fully two-thirds say things will get worse for them in 2015. ‘It depends on the geopolitical environment – if it stays as it is it will be bad.’

Some interviewees who contributed to the Emerging Trends report said they were already dealing with the fallout from Russia’s conflict with Ukraine. ‘Because we are present in nearly every country, whenever anything goes wrong we are hit,’ says a senior executive at a global advisory group. ‘Our Russian business, our Ukrainian business is pretty much on its knees. Our Turkish business is impacted. It is all because of geopolitics and has nothing to do with the economy or the real estate sector itself.’

For many, though, it is not the reality on the ground right now so much as the threat that such conflicts could escalate and hit business confidence. ‘There will be a market shock again but we do not know what it will be or when it will happen,’ says one. ‘The world is still recovering from 2007. Confidence is re-emerging but it is fragile. It does not take much to set it off and there are a lot of geopolitical risks and uncertainty in the market at the moment.’

At the same time, Europe is a market of many speeds and there is enough variety to attract investors at different ends of the spectrum from core to value-add and opportunistic. As one pan-European investor noted in the report: ‘The European market has basically been quite different from one country to another and also by sector. So we have been adjusting, almost on a quarterly basis, our strategy based on our research on each of these markets and the opportunities that arose from the variation in each market ... I view it very positively, but at the same time with caution.’

That is maybe the best piece of advice that can be distilled from the Emerging Trends report. The outlook has improved, but investors are advised to proceed with caution.

Judi Seebus
Editor in chief